Need Help Figuring Yield Please

[Lori Martinez]

Bigger Pockets Members,

I am having trouble trying to understand how yield works. I would most appreciative of your help. I have several courses including Calculator Power (but none give equation examples). I have a financial calculator and Tvalue software as well. (I need very specific examples shown in a course or website that would show me all about yield and how to figure yield).

Is there a place I can go that will show me how and what yield is, but more importantly, how to figure it on a calculator? (What formula is used?)

I am going through an old John Behle Paper Game course, and unfortunately he did not show how to figure the yield in this example. I have a pretty decent grasp on how he came about all his other numbers, but I am still learning.

I have a specific equation in mind that I need help with.

$10,000 Note
$ 6,000 Offer (discounted 40%)
120 Payments
10% interest
$132.15 Monthly Payment

Yield earned is 24%

(Question: I need help to show me how to calculate how the 24% yield)

Any assistance would be appreciated.

Regards,

Lori

[Dion DePaoli]

Sharon Hiebing

I believe I distracted myself with the 15.85% and had another use of that number which I was going to comment on but didn't come back to my point properly in the post and jumbled my thoughts a bit. Sorry for the confusion. Clearly, 1585.81/6000 does not equal 15.85% and the math is 26.43%. Lori emailed me but I didn't come back to the post and comment on my mistake.

At PAR the loans yield is 9.72%. It must be less than the interest rate, not more than the interest rate. The interest rate of 10% is the maximum cash flow the loan will have. A portion of that cash flow will be interest and a portion principal. For both, the borrower and the investor. However, the schedule of payments, since the loan is discounted, is not the same principal paydown for each party. If we want a barometer of what we are 'making', then we must only use what we are making to figure the number out with a linear equation such as X/Y = Z.

This concept illustrates the breakdown in the utility of the numbers being used for the calculation. If we apply the knowledge that says, the yield can't be more than the interest rate if the investment and the loan are equal to each other or a Par investment, we can sort of see the formula is flawed when we don't properly figure out what "X" is.

The 15.85% shows us the failure example of the above concept. The interest rate is 10%, so then the yield can't be more than the interest that accrues on the note. If we do $1,585/$10,00 = 15.85%. That means we are getting MORE money than just interest.

At the Discounted Price the investment's yield is 16.43%.

The 15.85% is giving us a percent telling us that $1,585 is 15.85% of $10k. If we take the 15,85% and see how many times that goes into 100%, we get 6.31 times. Which, we can use as years or multiply by 12 to get total periods. Periods = 75.72. If we take the full amount of payment per period, we can see that 75.72 periods paying $132.15 actually equals a little over $10,000. In other words, period payment 0 to 76 all pay the invested principal back and payments 77 to 120 all produce the profit.

The $1,585.81 is not just the interest being paid to the investor. It is all of the principal and all of the interest. Remember, the interest for year 1 is $972.39. Since we took the loan at a discount, we have money coming from the gross payment stream of $1,585.81 where a portion of the borrower's principal payment is also a portion of the investor yield.

A way to set this up is pay the original capital balance of $6,000 back within the term of the loan (120 payments). This puts the each investor payment at $50 per period or $600 each year. Taking note to remember, that profit is what comes above the initial investment.

$1,585.81 less the principal paid back is $985.81. $985.81/$6,000 = 16.43% Yield. There is the yield, that investment will make, provided the investment principal is paid back in this manner and the investment is made at this discount. The principal does not have to be paid back in that manner and the manner in which the principal is paid back can be altered according to the involved parties. The yield can be manipulated by manipulating the amount of capital that pays the investor back for the principal amount invested. You can really only do this when you purchase the loan at a discount.

So then, what is the number 26.43%?

This could be considered a form of return, but it consists of all the parts, both principal and interest. And perhaps the best lesson here is look to the formula to understand what the number is. That will not lead you wrong. The number tells us, $1,585.81 is 26.43% of $6,000. It tells us about all the cash flow. Not the net or not the interest by itself. We must solve to find the net cash flow or the interest.

Another way to look at it, 26.43% goes into 100% 3.78 times. So, it takes 3.78 Years to pay the $6,000 back if the gross amount is $1,585.81. This also equals 45.4 payments (3.78 x 12). ($132.15 x 45.4 = $6,000.00 (rounded)). So, if 100% of the proceeds were used to pay the investment back, the investment would be paid in full on payment 46. Payment 47 to 120 is all profit. Can we pay the investment back this way? Yes. Or we can pay only $50 per period or frankly any other number that is agreed to.

Since the investment is disassociated with the borrower, they can both follow different paths to zero principal. If the loan is at Par, we have less choice. This is because the borrower and the investment must pay to zero at the same time. So when the loan is at par, the investor and the borrower amortize on the same schedule.

When looking at the loan in par form then. We can also see that the interest in year 2 is less than year 1. Year 3 is less than Year 2. The principal in Year 1 is less than Year 2 and Year 2 is less than Year 3. Etc. We know this is the way a loan amortizes. It is this gradual reduction of interest payments and gradual increase in principal payments that reduces the Interest Rate to the Yield to Maturity. Where calculating Yield to Maturity would include adding up all the interest each year into the amount invested. It also illustrates if you purchase this loan at par in year 2, you will have a slightly different yield than in year 1.

Aside, from me perhaps making some of this confusing, you should see the relationship of the numbers, which is what I am driving at.

Calculating yield is not a bad idea. IMO, you are better off using an IRR (Internal Rate of Return) calculation as the best method to figure out what your actual return is opposed to yield, which may only be a portion of the return and can be distorted depending on the year or period the calculation is observed. In an IRR calculation, the formula uses the gross payment number from the borrower. So then, you don't have to mess with figuring out what portion is principal. In addition, the formula takes into account Time Value of Money.